A new IRS form is a wake-up call for e-retailers

Small online retailers are getting to know the 1099-K form, a document filled out by payment processors and used by the Internal Revenue Service to verify retailers’ reported incomes.

Introduced for the 2011 tax year, the 1099-K form was designed to help the IRS enforce income reporting by small businesses, including the thousands of retailers that sell through online marketplaces, says Mark Luscombe, principal tax analyst for CCH, a unit of Wolters Kluwer that provides tax and business information. “The 1099-K is an effort to use information from third parties to increase compliance,” he says.

Section 6050W of the Internal Revenue Code requires “payment settlement entities”—such as processors of Visa and MasterCard payment card transactions and payment services like eBay Inc.’s PayPal and Google Inc.’s Google Wallet—to report the total annual value of transactions processed for each client retailer on a 1099-K form prepared for each client. Payment processors send 1099-K forms for each client to both the client and the IRS. If a retailer receives payments through three payment processors, it will receive three 1099-K forms, one from each processor, the agency says.

There is a break for the tiniest of retailers. For payment services like PayPal, the IRS requires the 1099-K form only when the payment service provider processes for a retailer in a single year at least 200 transactions totaling at least $20,000 in transaction value. There’s no exemption in the processing of payment card transactions.

The IRS uses 1099-K forms to check for any inconsistencies in what a retailer has reported in its 1040 income tax return. “If the two forms don’t match up, the retailer will have to explain why,” Luscombe says.

The reported financial figures are gross numbers that don’t account for net income, however, and thus don’t factor in product returns, shipping expenses, chargebacks or other deductions from gross sales revenue, Luscombe says. Chargebacks occur when the card-issuing bank reverses a credit to a merchant account because of a consumer complaint, fraud or other reason.

That can cause a problem for retailers, especially small ones without accounting departments, to reconcile sales reported on 1099-K forms with the income a retailer reported on its 1040 business tax return, Luscombe says. “The bottom line is that retailers have to keep really good records,” he says.

Small online retailers say the task of reconciling 1099-K and other tax forms can be overwhelming. “With the 1099-K, there’s a lot of fear in the industry,” says Danni Ackerman, who sells antiques and collectibles on eBay.com and Amazon.com and advises others how to sell online. “Keeping a printout of every single sales transaction on eBay, I could spend hours and hours putting together information for taxes,” she says.

To escape those chores, Ackerman uses Internet-hosted software from Outright, a unit of web site hosting services company and web domain registrar Go Daddy. Outright offers bookkeeping software and services that provides Ackerman with detailed reports of both her transactions processed through each payment processor and her expenses, including eBay transaction fees and office supplies that can be deducted from gross income.

Retailers can use Outright to process 1099-K forms for no cost; the company offers a free basic service that provides reports on a retailer’s sales and expenses. To get reports on sales transactions sent through a payment processor, a retailer can click from Outright.com to link to the payment processor’s web site and fill out a form requesting the processor to send its daily transaction data to Outright, according to vice president of marketing Laura Messerschmitt.

Outright earns its revenue by offering Outright Plus, which comes with additional services, including reports on sales taxes in states where client online retailers are required to collect sales tax. Outright Plus costs a flat fee of either $9.99 per month or $99 per year, Messerschmitt says.

She adds that Outright, for which privately held Go Daddy doesn’t publicly report revenue, has grown its customer base by about 20% in recent months, to 300,000 retailers from 250,000. The company serves mostly small online retailers with annual sales of up to $1 million. Messerschmitt attributes the growth to growing concern among small retailers about processing state sales taxes as well as the 1099-K form. Pending federal legislation would require many small online retailers to begin collecting online sales tax.